Preference shares - contingent settlement

[hubertd]

Hi Everyone,

My preference shares related questions are coming thick and fast in line with our growing pipeline of preference shares and convertible loan notes investments. Let me know if you’re getting bored and I’ll take a break -) In the meantime…

I have a potential convertible preference shares investment with a discretionary dividend and a conversion option on 1 to 1 basis at any time at my discretion. The only eventuality for an issuer to redeem in cash would be on merger, acquisition or a sale of a company. These are clearly contingent events and the question arises if they are under the control of the company. These seem to me more like shareholders decisions and ‘Financial Instruments with Characteristics of Equity’ exposure draft from 29th November ‘23 states that a proper judgement is needed to establish if a contingent events at discretion of shareholders can be treated as the events under the control of the company’. I’m inclined to think these particulsr events wouldn’t be under the control of the company and the preference shares should be classified as financial asset held at FVTPL. One could however argue either way…What are your views?

[DJP]

Hi hubertd,

In my opinion, this is an equity instrument in the issuer's accounts. That is because the company can avoid paying cash by refusing a merger, acquisition, or sale of the company. These types of events always require approval from the shareholders and, therefore, they should be treated as events under the control of the company.

If we agree that this is an equity instrument, the financial asset must be carried at fair value. (I believe you could use the FVOCI option here).

[hubertd]

Thanks DJP, however have you ever seen the draft I mentioned? According to it shareholder consent doesn't equal to company consent and the more the action is actually instigated by the shareholders the less likely it is 'within a company control'. It's a highly judgemental area but the draft is very explicit in making this distinction.

[hubertd]

[DJP]

Yes, I had read the draft. I did a bit of more research and I think you are right, a change of control clause, which normally requires a special meeting -- i.e. it is not a routine shareholder decision -- should be considered a shareholders decision rather than an entity decision.

In any case, I find it difficul to accept to classify the instrument as a financial liability. Even though one can conclude that this is an event outside the control of the entity, the ordinary shareholders' decision should be in line with their interests. If it is not beneficial for them for the company to pay the pref shareholders, then they will simply not allow the change of control. I will do a bit of more research, but if you find anything else on this please do share

[Marek Muc]

My preference shares related questions are coming thick and fast in line with our growing pipeline of preference shares and convertible loan notes investments. Let me know if you’re getting bored and I’ll take a break -)

Keep those posts coming – you never know what might catch someone's eye!

BTW, are you thinking of submitting a comment letter on that Exposure Draft? Your insights from your experience could be quite valuable to the IASB.

[hubertd]

Yeap, this fleeting thoughts crossed my mind, Marek. I may yet to it indeed.